Over the last ten years, public awareness of climate change, population growth, energy security, water scarcity and the use of natural resources has grown as the implications of ‘business as usual’ have become increasingly clear. Policy-makers have responded to these challenges by introducing regulations which aim to mitigate the impact of these ‘mega-trends’ by introducing incentives for businesses and the wider public to move towards more sustainable practices. 

As these issues have increased in prominence, a wider stakeholder group, including institutional investors, trade unions and the media, have begun to more closely monitor progress made by companies on environmental, social and governance (ESG) issues. 

Private equity is ideally suited to instituting, identifying and generating additional value through a focus on ESG management

Previously some way down the corporate agenda, effective management of ESG concerns is becoming an item of genuine importance, with reporting of ESG management programmes and performance increasingly widespread. There is a growing understanding that effective management of ESG issues can have a significant impact on corporate profitability and value. 

Of all models of ownership, private equity is ideally suited to instituting, identifying and

Adam Black, Doughty Hanson: more for private equity industry to do on ESG

generating additional value through a focus on ESG management. Private equity investors typically take majority (or at least substantial minority) positions in companies, giving them a large degree of control over their development, with their investment horizons tending to be much longer term than those of investors in listed equity. 

The private equity industry has experienced substantial growth over the past 20 years precisely because of its ability to influence companies in which it invests and create value for institutional investors. The industry has been at the vanguard of a hands-on approach to asset ownership through a focus on operational improvements. 

However, the industry hasn’t applied these principles to sustainability at the sort of scale one might expect, given its ability to influence change at the portfolio company level. 

A recent Doughty Hanson report, published in partnership with conservation grouo WWF, Private Equity and Responsible Investment, demonstrates how value can be created by increasing the operational efficiency of portfolio company operations not solely in traditional financial terms, but through effective management of natural and human capital. A small addition to an already proven approach – to focus specifically on ‘eco-efficiencies’ such as waste reduction, energy efficiency, water savings – can generate a double dividend: an improvement of financial returns and the reduction of a company’s environmental footprint. 

An oft-repeated criticism is that it is difficult to quantify the financial value of ESG measures. While it is true that quantifying the impact of sustainability initiatives is challenging, and there is no generally accepted methodology, it is possible to calculate their financial benefits.

Private equity is about building better businesses. Addressing sustainability within portfolio companies is perfectly aligned with that aspiration

The report reveals that private equity-owned United Biscuits, for example, has saved approximately £25 million ($40 million) per year in the past five years through environmental initiatives, including an initiative to run its vehicle fleet on biodiesel made from the waste vegetable oil from its snacks factories. LM Wind Power, a Doughty Hanson portfolio company, achieved savings of €6.2 million ($8.4 million) in 2010 after introducing waste reduction measures. 

In essence, there are three aspects to sustainable investing: first, efficiency and cost savings, which is ultimately about producing more with less, with reducing energy usage a good example; secondly, and an increasing area of focus, is the development of new products or services which capitalise on the ‘green’ market opportunity; thirdly is the management of potential reputational damage by undertaking environmental and social initiatives designed to reduce risk. This also includes avoiding costs associated with non-compliance with ESG regulations, poor ESG management and/or a failure to identify and manage possible ESG issues associated with the supply chain. 

Approaches and attitudes to ESG issues are evolving – marking a transition from a mindset dominated by compliance with regulations, risk mitigation and liability assessment, to an approach that seeks longer-term strategic advantage and sustainable value creation. 

Private equity is about building better businesses. Addressing sustainability within portfolio companies is perfectly aligned with that aspiration. Firms that understand this will give themselves a long-term, competitive advantage. 

Adam Black is head of sustainability at UK-based private equity firm Doughty Hanson